The Vodafone Group has just won one of the most high-stakes legal battles involving a foreign investor and the Indian state under international law. An Investor-State Dispute Settlement (ISDS) tribunal, constituted under the India-Netherlands bilateral investment treaty (BIT), has ruled that India’s imposition of tax liability amounting to ₹22,000 crore on Vodafone is in breach of India’s BIT obligations.
Shaking the faith of foreign investors
This case arose after the Indian Parliament in 2012 amended the Income Tax Act declaring that income deemed to be accruing to non-residents, directly or indirectly, through the transfer of a capital asset situated in India is taxable retrospectively with effect from April 1, 1962. Obnoxiously, this amendment was carried out to override the Supreme Court ruling in favour of Vodafone. The Court held that Vodafone didn’t owe any tax to the Indian state on account of acquiring a 67% stake in Hutchison Essar through an offshore transaction. At that time, the likes of Montek Singh Ahluwalia, Deputy Chairperson of the Planning Commission, counselled against amending the law retrospectively, but the then Finance Minister Pranab Mukherjee, the architect of this law, ignored this sane advice. This amendment dented India’s reputation as a country governed by the rule of law, and shook the faith of foreign investors.
Editorial | Salutary lesson: On the Vodafone case
The BJP, which was in the opposition, vehemently criticised the retrospective amendment calling it “tax terrorism”. Thus, when the Modi government assumed office in 2014, many believed that the law would be amended and made prospective. Given the Modi government’s enormous political capital, this was attainable. But the government did nothing to change the law. Like the United Progressive Alliance government, it strenuously pursued the act of fiscal plundering hoping to mobilise sizeable revenue.
While a detailed legal analysis of the case will have to wait until the arbitral award is available, there are several points worth noting. First, the tribunal has ordered India to reimburse legal costs to the tune of more than ₹40 crore incurred by Vodafone in fighting this case. In other words, the taxpayer’s money will be used to pay Vodafone. So, the important lesson is that all the three organs of the Indian state — Parliament, executive, and the judiciary — need to internalise India’s BIT and other international law obligations. These organs need to ensure that they exercise their public powers in a manner consistent with international law, or else their actions could prove costly to the nation.
Second, India should learn that being a country that values the rule of law is an important quality to win over the confidence of foreign investors and international goodwill. Unleashing tax inspectors to extract money out of foreign investors by constantly changing the rules of the game is not an attribute that a liberal democracy should be proud of.
Honouring international law
Third, it is likely that the government might challenge the award at the seat of arbitration or resist the enforceability of this award in Indian courts alleging that it violates public policy. If the government indeed follows these options, there’s a long, gruelling road ahead for Vodafone. The government would be ill-advised to go down this road because it would mean that India does not honour its international law obligation. It would send a deleterious signal to foreign investors reaffirming the sentiment that doing business in India is indeed excruciating. Fourth, this ruling might have an impact on the two other ISDS claims that India is involved in with Cairn Energy and Vedanta on the imposition of taxes retrospectively. Fifth, it is quite possible that India might use this award to further harden its antagonistic stand against ISDS and BITs. As is well known, India unilaterally terminated almost all its BITs after foreign investors started suing India for breaching BITs. The belief in the Indian establishment is that the ISDS regime unduly intrudes into India’s sovereignty. Thus, this decision might be used to strengthen this populist narrative, oblivious of the fact that this case and several others are a result of bad state regulation.
Finally, this decision shows the significance of the ISDS regime to hold states accountable under international law when in case of undue expansion of state power. The case is a reminder that the ISDS regime, notwithstanding its weaknesses, can play an important role in fostering international rule of law. If the Modi government is serious about wooing foreign investment, India should immediately comply with the decision.
Prabhash Ranjan is a senior assistant professor of law at South Asian University and the author of ‘India and Bilateral Investment Treaties: Refusal, Acceptance, Backlash’. Views are personal